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Raghavan and Radhika Ranjan recently purchased their own apartment, their first big-ticket investment. It was an achievement for them considering that they are in their early thirties. The process of finding the right property, completing the paper-work, furnishing took the Ranjans nearly 10 months.
During this period, managing their personal finances was not difficult since the amounts they had earned / saved were earmarked and expended towards margin money, stamp duty, brokerage, interiors, white goods, parties for friends, relatives, and so on. However, once they were done with setting up home, they began to think about savings. Relatives and well-wishers warned them to close their home loan as soon as possible. Colleagues and friends suggested focusing on long-term investments. The Ranjans were confused about their next step. With double incomes (and no kids), savings were not a problem. They could still put aside some money every month. They were not really concerned about the home loan as they had a 25-year long period to repay it. Long-term savings appealed to them since they regarded their capacity for risk to be high and buying the house had wiped off their past savings.
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The Ranjans' dilemma with regard to savings is one of the most common problems that first-time home buyers in the age group of 28-35 years face. Home buyers in this age group should keep in mind the following five strategies.
Keep a check on EMIs; go for longest tenure
Actually, the first leg of the strategy begins before finalising the budget for a home and the loan component. Two important factors a prospective home buyer should bear in mind are:
First, the equated monthly instalments (EMI) on the home loan should not exceed 50-60 per cent of the net (in-hand) family income. Any EMI higher than this, though it may look comfortable and easy in the beginning, could turn out to be a recipe for medium-term financial hardship.
Second, while signing for a loan, always aim for the longest tenure a lender can offer even though you may be tempted to see the loan off your back within a shorter span. This will keep EMIs at the lowest levels, without putting squeezing monthly savings. Borrowers, in a bid to repay a loan early, often approach lenders to raise EMI levels (especially after receiving yearly increments) in the belief that this would help shrug off the loan burden earlier than later. This is best avoided. There are other ways to repay loans faster.
Pay off most of the loan in the first five years
Under the EMI feature of a home loan, the maximum interest on a loan is charged by borrowers in the first five years of the tenure. But ironically, many home-loan borrowers make plans to prepay their home-loan liabilities any time after the first six to eight years of the tenure.
Borrowers who are serious about paying off home loans before the contracted tenures should plan for accelerated repayment and try to pay off the largest liabilities in the first five years. At least 20 per cent of the monthly family savings should be kept for this. It can be topped up with the annual variable payouts/ bonuses or any windfall gains such as ESOP gains made during the year. These savings can be utilised to make prepayments at specific pre-thought out intervals or whenever a borrower hikes the interest rate on the loan, whichever is earlier. Factors such as tax savings on the home-loan interest paid should not stand in the way of accelerated repayment. Although a borrower (in the maximum tax bracket) saves 30 per cent on the interest cost, 70 per cent of the interest paid is still a cost for the borrower.
Also, people looking to make gains on property investments should keep in mind that a longer loan tenure implies higher interest, thereby increasing the cost of the property.
Opt for overdraft facility on home loans
A few banks offer the overdraft facility, linked to a home-loan account. Under this, a borrower opens a current account with the bank in addition to the home loan account. Any deposit made by a borrower into the current account is utilised to reduce the outstanding amount in the loan account, and interest is charged only on the balance in the loan account. Thus, although a borrower does not earn any interest on deposits in the current account, s/he saves interest on her/his home-loan outstanding, thereby earning implicit interest on the balance. Besides, a borrower can withdraw the amount in the current account, at any time. Thus, this facility helps a borrower to reduce the interest due on a home loan without compromising on liquidity.
Change the monthly savings pattern
Most people in the 28-35 years age group end up utilising their savings to fund their house purchase and to set up a home. After this, while they start saving and investing again to build up their investment corpus for other family-oriented responsibilities and objectives, the time-frame should be short-term. In other words, the risk portion in the monthly savings should be watered down to provide for any unforeseen emergencies. The family should look to build a corpus of at least 25 per cent of the outstanding loan amount before embarking on any medium to long-term savings. This may take anywhere between two and three years.
Build an emergency fund
Building an emergency fund immediately after purchasing a home should be one of the highest priorities. Apart from family contingencies or medical problems, this emergency fund can also be used to pay a lump-sum for society maintenance, property taxes, or buying some appliance not earlier budgeted for. The quantum of this emergency fund could vary from family to family, but should be closely watched and reviewed from time to time.
The three to five years after a home purchase are crucial. By exercising some financial prudence, young home buyers can lay the foundation for a secure financial future.
The author is a Chartered Accountant
